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How interest rates affects oil prices

January 09, 2008 16:28 IST

Here's the most nonsensical headline of 2008 to date: "Banks face rates dilemma as oil price soars," according to the London Evening Standard.

"Pressure is growing on the Bank of England for another cut in interest rates next week. Consumers face soaring petrol bills while their spending is being squeezed by higher mortgage payments and rising energy bills," continues Nick Goodway, the journalist.

Lower interests rates are not going to bring oil prices down, we're pretty sure of that. Nor will Gold Prices suffer much if official government currency becomes cheaper to print and borrow once more. But Goodway notices the problem faced by consumers in the Western world. Energy prices are rising. Interest rates want to rise, increasing the cost of carrying a lot of debt (nearly as popular as oil in the West).

The trouble is that the rising oil price is already a result of interest rates that were too low for long. Oil now has a fundamental economic momentum of its own. People everywhere want it. But it's harder to find. And so the price rises. Central bankers can't do much about that, and cutting rates won't make a lick of difference.

So 2008 begins much as 2007 ended. Investors are whistling past the proverbial graveyard, hoping that 10 years of credit-driven speculation in financial markets will go bust quietly, without any real economic consequences. Oil and gold prices tell us that there are already consequences.

The oil price came off $100 late last week. Byron King, our colleague in the United States, says the geology is leading off-shore oil explorers straight to Namibia. It could be "the next big thing."

And what about financial markets in general? CLSA's Chris Wood, who writes a client newsletter called Greed and Fear, puts it this way: Greed & Fear's long-term view remains what it has always been since Nasdaq peaked in 2000. This is that Asia is in a structural bull market and America is in a structural bear market; though the extent of the downside in US equities will be determined in the longer term by the relative strength of the US Dollar.

As for Asia currencies, the story is much clearer. They remain in long-term bull markets, just like the region's stock markets.

And the Gold Market - how does its seven-year bull run fit into the big trends of 2008 so far? Kicking off the New Year with a series of all-time record high Gold Prices has only led to a new rash of mainstream-magazine and newspaper stories on the yellow metal. Given that the current surge is being driven by investor demand, that may - or may not - signal some kind of short-term top. But we're certainly not betting against bullion in 2008.


Formerly editor of Strategic Investment with Lord William Rees-Mogg, Dan Denning is an independent investment analyst now based in Melbourne, from where he edits the Australian edition of The Daily Reckoning. He is also author of the best-selling The Bull Hunter (Wiley & Sons).

Dan Denning